Monetary Realismhttp://monetaryrealism.com
Understanding The Modern Monetary System...Sat, 03 Sep 2016 16:29:09 +0000en-UShourly1The Future of Money is Cancellation and Controlhttp://monetaryrealism.com/the-future-of-money-is-cancellation-and-control/
Sat, 03 Sep 2016 16:29:09 +0000http://monetaryrealism.com/?p=3528Read More]]>The future of money is full government control and knowledge of what was spent, where it was spent, and what it was spent to purchase. And its going to happen very, very soon.

“A legal digital currency must solve this problem thoroughly, both by protecting user accounts with cryptography and by establishing a controlled anonymous system to ensure that transactions can be traceable under certain condition”

The only reasons to trace transactions is to find out if the settlement process worked both legally and as intended. The intention behind a settlement process is only important to the parties in the transaction, however, the legality of a transaction is purely a government concern.

Let’s imagine a future where block chain technology is applied to all major asset classes. The entire history of transactions associated with each individual segment of the asset is easy to trace as it is contained on the ledger associated with the individual asset. The ownership history of an asset can then always be traced!

Adding “what was paid for this asset during the transaction to the ledger” will be trivial. Adding the payment method, quantity paid, and even more details will become a standard part of what you purchase when you buy an asset.

This will be proof this transaction was not part of some money laundering or other illegal ‘scheme’, and that you personally acquired it through legitimate means.

Of course, the eMoney paid for these assets will also have a trail. The PBoC is clear this is one of the end goals of their vision of eMoney, and I’d be shocked if the central bankers of the US and the Eurozone thought any differently. Illegal transactions are illegal for a reason, and finding ways to prevent illegal actions before they happen is a primary goal of most law enforcement officials.

You can see where this is going – full transaction history of assets that include what was paid for the asset will become the standard to insure the asset has a clean, clear, and fully legal provenance. Assets that do not have this will become impaired in value relative to assets with an established fully-legal provenance.

Any possible anonymity provided by some sort of eMoney will only be part of the control structure. And soon, people will begin to insist their money also has this provenance. You can imagine a company like Apple, Amazon, or eBay insisting that any eMoney used to purchase from their site has a fully established legal provenance in order to purchase goods on their site. Imagine the SEC insisting stock transactions involving eMoney have eMoney with an established legal provenance.

And we come to the 800 pound gorilla of getting paid, the Internal Revenue Service. Imagine the IRS says “show the eMoney you use to pay us has a clear legal provenance”. This will be easy to do with eMoney – it will be easy to put a “in exchange for CCC” field into the transaction ledger.

We currently do not have a way to establish provenance of money. eMoney will have this capability, and it will be used by governments to control eMoney, largely through insisting any eMoney used to pay the IRS or buy major assets has clear legal provenance.

Problem: Long transaction history. The transaction history of a single unit of money can quickly become long, so how can we solve the provenance and long history problem? One way would be that fully legal deposit institutions like banks or holding account providers could destroy the transaction history, and then issue ‘new and fully legal’ eMoney to their depositors as they use this money out of their account.

Problem: the eMoney is used illegally. The government will issue an update to banks and other deposit institutions that this money cannot be deposited and ‘cleaned’. Major retailers will be not accept this money, because they won’t be able to deposit it. This money will be effectively cancelled.

Hey all of this is terrifying, but it sure seems like this has a reasonable chance of happening, and happening relatively soon! Sleep well.

]]>Helicopter Money Policy Formulationhttp://monetaryrealism.com/helicopter-money-policy-formulation/
Wed, 24 Aug 2016 11:27:03 +0000http://monetaryrealism.com/?p=3519Read More]]>An important aspect of helicopter money is just how a central bank would obtain the authority to undertake such a policy. Eric Lonergan is a leading proponent of HM. As he points out, the resolution of this issue could depend on the institutional regime for the central bank in question. For example, it may be quite different in the case of the ECB than for the Fed, the Bank of Canada, or the Bank of England.

In all cases, however, the delegated authority should be clear in delineating how helicopter money relates to standard fiscal and monetary policy responsibilities. I left the following comment along these lines at Eric’s post on the institutional perspective:

I agree that institutions matter. And words and definitions should be used carefully for framing and communicating the policy. That’s why I think it is helpful to sort out the use of the terms fiscal policy and monetary policy as best as possible. Some influential types like Michael Woodford use fiscal policy in the description of helicopter money from the get go. So the issue of semantics can’t really be avoided. If connection between fiscal policy and monetary policy is made as clear as possible, all the better.

If helicopter money ends up being done in a notable way, the effectiveness of it will have something to do with its announcement power and that the central bank is seen to have the authority to execute policy with something quite novel in its “tool-kit”. It is in that sense that I believe there is at least potential for it to have a greater effect than say – for example – an economically equivalent policy (some would say) of government spending or transfer payments financed by Treasury bill issuance.

Central bank operations have a fiscal effect in their conventional scope. This arises from the profit (or loss) contribution resulting from a CB’s financial intermediation activity.

Unconventional operations such as qualitative or quantitative easing expand the scope of asset activity and increase the size of the monetary base beyond conventional trends.

In general, it is the asset and liability classes involved in these conventional and unconventional policies that define the scope of permissible financial intermediation activity.

Helicopter money differs from these conventional and unconventional monetary policies in the timing relationship between government spending or transfers and corresponding money financing. With either OMO or QE, , there is obviously a requirement for some type of standard fiscal action to have been undertaken in the past so as to create the budget deficit conditions for the issuance of government debt that is available to purchase from the market place. With HM, money financing supports spending or transfers that are essentially concurrent with the financing.

The proposals generally floated for helicopter money include several variations on operational arrangements. The one that seems to involve the central bank for the most part is the example of transfer payments made by a CB directly to households without operational involvement by Treasury. The payments are directly monetized to bank money and bank reserves. A different route involves Treasury at the operational level, with the central bank directly crediting the Treasury account (i.e. without the intermediation of bonds), from which Treasury spends or transfers funds that are subsequently monetized in the form of private sector bank money and bank reserves. A third option includes a central bank that acquires government debt newly issued to finance concurrent payments from the Treasury account, with those payments subsequently monetized in the form of bank money and bank reserves. This last option can be viewed as the logical limit of QE – the limit as the time lag between Treasury debt financing and central bank purchase of that debt goes to zero.

A consistent timing nexus is evident in all of these proposals. It is perhaps most clearly delineated in the third case of concurrent bond and money creation – seen as the limit of QE as the time lag between fiscal and monetary operations goes to zero. But in all three alternatives the same relationship holds between the timing of a standard type of fiscal action such as spending or transfer payments and the timing of money creation – it happens at essentially the same time. There is no lag. I think this timing consideration is the key to delineating a natural fiscal and monetary policy nexus for helicopter money. If fiscal policy is defined to include spending or transfers, and if monetary policy is defined to include monetary base creation, then HM has a dual fiscal and monetary policy characteristic.

Where does this leave us in terms of framing of fiscal and monetary policy vocabulary in the case of helicopter money?

I’m not a fan of the “already doing it” interpretation of standard central bank activity as it relates to helicopter money. For example IOR (including recently implemented tiered structures in a negative interest rate setting) is a matter of the interest expense structure, which is a subset of the profit determination which in turn becomes the standard central bank fiscal contribution in a structural sense. While it may be tempting to attach economic interpretations of tax-like properties in some cases, this is a structure that is determined by the central bank and therefore is part of monetary policy proper. Moreover, the motivation for the expense structure has much to do with operational requirements corresponding to interest rate policy objectives for the central bank. The same technical argument cannot be made for helicopter money – other than in a somewhat indirect way. Therefore, I see no persuasive interpretation of IOR as a precedent for central banks assuming the helicopter file as core monetary policy.

I am sympathetic to the idea that – if the central bank does it in fact – it’s monetary policy. Monetizing either financial assets or standard concurrent fiscal payments is monetary policy in that sense, be that OMO, QE, or HM. But that’s only one side of the transaction. The other side is the fiscal characteristic of the act of spending or transfer. And if it turns out that the two acts are coincident – as in the case if a central bank were to make a standard type of transfer payment to a household – then that coincidence is one of fiscal and monetary policy. And the central bank in that case executes both fiscal and monetary components. The policy implementation responsibility is a composite one – including a received delegation of authority to act in a standard fiscal capacity, which is clearly different than is the case for the standard financial intermediation contribution of the central bank.

However, such a delegated HM authority has a natural origin in an overarching fiscal policy framework that ideally should include the formulation of an overall spending and transfer capacity – adjusted appropriately for the risk implications of corresponding financing mix – with the central bank being delegated an authority to take on some of that capacity in the form of a dual-policy helicopter mandate. Such a “risk allocation” approach puts fiscal policy at the heart of HM.

]]>MMT Againhttp://monetaryrealism.com/mmt-again/
http://monetaryrealism.com/mmt-again/#commentsSat, 11 Jun 2016 21:52:15 +0000http://monetaryrealism.com/?p=3503Read More]]>I thought we’d made peace on this topic a long time ago, but I guess not according to these comments….Against my better judgment I am going to respond to some of them….

I don’t really align myself with any particular school of economics because I believe there is enough gray area in economics that it’s dangerous to pigeonhole one’s self into a fixed set of ideas. I learned this lesson the hard way in 2011 when I briefly promoted Modern Monetary Theory (MMT) online. Although I never fully adopted all of their ideas I did promote many of the general ideas. And as a Post-Keynesian sympathizer I still think many of these ideas are good. But it was my mistake in misunderstanding the entirety of the theory and I should have known better than to endorse something that was so new and not widely accepted by, well, anyone in the mainstream. That said, I think my critique is more valid than ever even if MMT advocates will dismiss a partial critique entirely. But let’s look at some of the comments there because a few are good (even though most are just nonsensical ad hominems of the type we, unfortunately, still see at MMT websites).

“Kristjan” writes:

” Some involuntary unemployment is the natural state of a capitalist system where capitalists will hoard profits over time and fail to maintain zero involuntary unemployment because it would be unprofitable for them to always maintain such an environment. ”

What an idiot Cullen has become. This garbage doesn’t deserve a reply.

What an idiot I must be! There is vast empirical and historical evidence showing that capitalist systems do not maintain full employment on their own. My theory is that this is largely due to capitalists unintentionally maintaining a buffer of unemployed people because capitalists cannot perfectly predict the future, tend to operate irrationally at times, do not sell all of their goods and services available, prefer to maximize profits and tend to monopolize profits if not regulated. Capitalists would prefer to be able to sell their goods and services without any costs which is now unfolding in the form of automation and other technological efficiencies we’re seeing across the economy. In an extreme sense, capitalists would love to be able to sell their goods and services without hiring even a single employee which means that full employment is a goal that is inherently at odds with maximizing profits. I am not saying that’s right or moral or anything like that. It just is what it is. Perhaps my theory is wrong, but there is still zero evidence supporting the idea that a capitalist system can maintain full employment at a living wage for any sustained period of time. In fact, I am not sure it has ever happened for even an instant, but I could be wrong….but what’s weird is that, if my theory is right, then the argument for government intervention is actually enhanced. That would seem to be in-line with the MMT Job Guarantee, no?

“Ignacio” writes:

So he basically is throwing the NAIRU argument around? What a fool…

Actually unemployment is not a feature of a capitalist system, with no wage floor there can be zero involuntary unemployment. It would be slavery in anything but name (well, worse than slavery, because you don’t receive anything on exchange, at least slaves have to be feed), but hey, they would be employed…

What a fool I must be! Except, slavery isn’t employment so I don’t think we really need to respond there. And no, I’ve rejected NAIRU vehemently. Again, I disagree with the idea that full employment can be maintained by capitalists on their own. And I don’t know of any empirical evidence proving this wrong….

“Bob” writes:

What is Roche up to nowadays? How’s that Monetary Realism working out for him?

How nice of you to ask Bob! This site has slowed because, well, none of us are economists! So, we write about econ theory on occasion and probably not nearly as much as we wish. Me personally, I am focusing on the same stuff I’ve always been doing – helping people build and maintain low fee diversified portfolios and financial plans. I’m trying to fight off all those bad guys in the financial space that we don’t like so much – you know, the high fee hedge fund guys, mutual fund guys and other high fee types who I don’t believe add much value.

Further, I am not an economist and largely dabble in this stuff because it overlaps with bits of my professional work. Importantly, I don’t care for theory or policy so much and tend to focus on the operational nature of these ideas since, as a market practitioner, I am more concerned with how the markets work and not necessarily how theory and politics can make them work better. Not that I think that stuff isn’t important, but I am a big believer in the idea that you can’t fix something you don’t fully understand. So, if anything I hope some of my work helps people better understand some of the operational aspects so they can endorse better policy ideas.

That’s. Pretty. Clear. Economics should be progressive. So I don’t see what the beef is there. What I find disturbing about some MMT commentary is how they sometimes try to convince people that it isn’t aligned with a political narrative and instead can be embraced by Conservatives and Liberals. It’s great that MMT is inherently progressive, but what I don’t understand is that they sometimes shy away from this. If you’re going to directly endorse policy then we should clarify what those policies are so people can fully understand them. But who cares if MMT is progressive? It’s a theory that is much more likely to be embraced by Marxists, Socialists and Liberals. That’s totally fine. I don’t see what the fuss is about!

Anyhow, none of this actually touched on my actual critique which is a shame because I think there are some fairly solid points there. But the flaws I highlight shouldn’t overshadow the many good points that MMT makes. After all, there is much more good in MMT than bad. The fact that it isn’t a perfect theory doesn’t make it a useless theory. Personally, I find MMT very useful, but I also think they overreach on some things. I probably do that also and I suspect that most econ schools do. So what. Now, can we all stop the mud slinging and name calling so we can make sure that a racist egomaniac doesn’t end up in the White House?

]]>http://monetaryrealism.com/mmt-again/feed/2Helicopter Recall – Fiscal Repairs Neededhttp://monetaryrealism.com/helicopter-recall-fiscal-repairs-needed/
Mon, 23 May 2016 14:47:01 +0000http://monetaryrealism.com/?p=3485Read More]]>“Helicopter money” (HM) is a term invented by Milton Friedman to refer to the fantasy of a monetary authority (central bank) distributing money – ex nihilo, in the absence of any related asset acquisition – as a way of stimulating aggregate demand. It’s an idea that’s permeated the blogosphere in recent months, in the wake of the financial crisis, for obvious reasons.

To take a recent example, Brad DeLong writes the following in support of interpreting HM as fiscal policy executed by central banks:

“The actions of central banks have always been “fiscal policy” in a very real sense, simply because their interventions alter the present value of future government principal and interest payments.”

This is a somewhat desperate rationale for the institutional legitimacy of central bank helicopter money. All financial assets are affected by the general level of interest rates as influenced by central banks – not just government debt. Moreover, government treasury departments do not design their funding strategies based on the present value of outstanding liabilities. They manage debt strategy according to the requirements of the cash budget, including servicing of outstanding debt. They don’t do this by trading a massive portfolio of present value risk. The present value perspective, while maybe attractive to academic sensibilities, is not directly important to the real world fiscal management of government cash flow. Scenario based projections of cash flow are the more relevant focus for budget risks.

Economists in recent times have manufactured a number of notions in an attempt to frame helicopter money as the natural purview of central bank monetary policy. Mainstream economics seems determined to abandon the intended institutional division of responsibilities between fiscal and monetary policy, while presenting contorted interpretations of responsibility to justify central bank authority to implement Friedman’s helicopter strategy. In this particular case, “present value-itis” constitutes one of the flimsier rationales, invoking ephemeral discount mathematics instead of examining actual fiscal and monetary operations under intended institutional responsibility and coherent policy formulation and implementation.

Helicopter money at its core is a fiscal idea corresponding to fiscal responsibility. Crediting commercial bank money accounts or even “dropping” currency ex nihilo to selected private sector recipients – with no financial assets received in exchange – constitutes a transfer payment, which according to common sense is a form of government spending. And spending is part of fiscal policy. So helicopter money is about spending from the government budget, with financing provided by the creation of new money, instead of taxes or debt. The transfer of money from the government to the private sector, without financial assets in exchange, is a fiscal transaction. It is no less fiscal than the same amount of money used by the government to pay for public works. It is no less fiscal than would be the case if financed by bonds or by taxes.

Friedman’s idea includes “money financing” (i.e. money creation) as an essential characteristic. I won’t address the effectiveness of money versus bond financing in this essay. That question is important and pertinent to both helicopter money and quantitative easing (QE), with a choice that warrants plenty of debate in its own right, in both cases. But I consider here only the use of fiscal and monetary architecture in implementing the idea underlying helicopter money – i.e. including the implicit assumption that some method of money finance for fiscal distributions has merit and is preferred to market bonds as the ultimate form of finance in the circumstances. In that context, the substance of the HM idea requires a straightforward justification as to why a program of fiscal transfers (or other types of spending foreseen under an HM proposal) is appropriate, and then why the associated money financing is appropriate as a facilitation. Assuming such justification, I conclude that the usual HM proposal can be converted to an accelerated or co-ordinated QE process with targeted fiscal expenditure by Treasury and immediate money financing by the central bank. This is contrary to most proposals for HM that envisage the central bank as making direct fiscal expenditures on its own account.

Money financing falls naturally under the operational framework of monetary policy. But fantasy helicopter drops are more than money financing. They are also government expenditures. It happens that the instrument of spending coincides with the instrument of financing. But spending and financing are not the same thing. They are no more the same thing than a bank loan and the bank deposit that it creates. They are no more the same thing than macroeconomic investment and the equivalent quantity of macroeconomic saving that it creates.

Central banks normally expand the monetary base by creating loans or acquiring securities. They do this in response to the needs of banks and the public for reserve balances and currency. In recent years they have extended this practice to the unconventional mode of quantitative easing, acquiring financial assets to supply reserve balances and bank money beyond conventional requirements.

This does not mean that any imaginable means of expanding the monetary base falls within the exclusive purview of monetary policy. In particular, it does not mean that a fiscal operation that is somehow jiggered to effect an immediate monetary base effect suddenly falls within the purview of monetary policy. But that is what the helicopter proponents want to argue.

The true role of accounting is fundamental to understanding these distinctions. Accounting reflects operations and operations reflect policy. If a central bank undertakes a fiscal expenditure operation, it will deliberately blow a hole in its balance sheet and create a negative capital position and a mismatched balance sheet. This activity is obviously not legitimate as a delegated responsibility for central banks. It is a usurpation of fiscal responsibility that produces a corresponding deformation of the central bank balance sheet. Accounting reflects operations and operations reflect policy. This is policy hijacking.

By contrast, the usual government treasury financial position is that of a net liability profile resulting from deficit financing over time. This profile is naturally “unbalanced” in the context of how we usually think of balance sheet management and accounting. But this institutional exception is easily understood by comparison with the normal private sector case. The government has the power of taxation, and therefore can manage a net liability position and sustain it in a way that isn’t generally possible in the private sector. It has a claim on the future that just isn’t available to the private sector.

Empirical evidence abounds for the effective sustainability of such a net government debt profile over time. By contrast, holders of private sector equity will obviously suffer from claims on negative book equity, because they have no similar claim to the backup role of taxation. Indeed, private sector taxpayers instead are in effect the last resort equity providers for the government sector, bound by the role of taxation as the ultimate means for controlling a sustainable net debt exposure, which ironically is what allows that net debt position to grow over time. Taxation is in effect a transfer of equity value, notwithstanding the ongoing negative book equity position that is typically the case for the transferee.

The central bank is different. Its balance sheet profile is suited to the facts of its delegated responsibilities. Its presumed independence exists only as a function of that delegated authority and law. And provided the central bank operates with that law, it can operate otherwise independently from a fiscal authority that has mostly separate operational responsibilities. The issue of the appropriate or sustainable size for the fiscal authority’s net debt position (including debt held by the central bank) is separate from the delegated responsibilities of the central bank.

The central bank’s function as an institution is to manage the production of the monetary base (i.e. manage its balance sheet) through financial asset acquisition and short term interest rate control. It has a delegated authority with laws under which to do this. It has an integral balance sheet with coherent financial accounting in order to track its performance under this authority. Its capital position is the essential connection to an overarching fiscal framework, including the regular mechanism for distributing central bank profit to the government treasury function. That profit is the fiscal effect of executing monetary policy under a delegated central bank authority.

The economics profession lately likes to argue that because the balance sheets of central banks are not necessarily subject to the same harshness of effective solvency constraints as private sector balance sheets, they should be freed up to implement helicopter money. But this overlooks the intention of the institutional design. That design, which includes a coherent balance sheet with a well-defined capital position, is not the product of some naïve view of government solvency economics. We obviously know that central banks if forced/allowed could continue to operate on the basis of their liquidity production powers, whether or not capital positions are technically positive. But a coherent central bank balance sheet reflects the objective of transparent accountability in how their operations affect the government fiscal position. That effect flows through regularly from the capital position to the Treasury in the form of distributed profit, reflecting for the most part a positive net interest margin and seigniorage benefit.

Conversely, a central bank with a negative capital position (for example, as would be a consequence of HM) is operating in an asymmetric world of shrouded accountability – where net fiscal benefits have been passed on to the Treasury but net fiscal expenses (such as would occur with helicopter expenditures or transfers) have been buried in a mismatched central bank balance sheet, instead of being precluded at the outset by consistent policy, or at least recovered by recapitalization in the form of a government bond distribution from the fiscal authority. In this asymmetric accountability mode, profits from central bank operations are recognized in the government budget while losses are buried in the form of disappearing bonds and a mismatched balance sheet. This asymmetry is no model for proper accountability of central bank operations.

An HM expenditure or transfer as proposed is a net fiscal cost, because it has not been financed with taxes. This would be the case whether the money is distributed by Treasury or by the central bank. Note that this criterion does not directly depend on whether the ultimate financing consists of market bonds or central bank money. The fact that HM as proposed uses money financing reflects the usual case that the central bank issues money rather than its own bonds. But if it did issue bonds instead of money, an HM distribution would still be a fiscal cost.

Not only is an HM distribution a net fiscal cost at the point of disbursement, but it results in further net fiscal costs as a result of the future interest cost of deficit financing. And again, this deficit accumulation over time is the case whether the money is distributed by Treasury along with bonds or by the central bank with or without bonds. All fiscal deficit financing results in a future cost (unless reversed by future surpluses) in the form of either the interest paid on market debt or the interest paid on bank reserves (except for growth in currency issued). (The latter alternative holds both in the actual case of the net interest cost when bonds are held by the central bank and in the fantasy case of HM with negative central bank capital.) In today’s unusual slow growth environment, the interest rate on either debt or bank reserves conceivably might be positive, zero or negative. But zero bound adventures, however long they last, should not obscure fact that HM distributions as proposed are as much a fiscal transaction as are bond financed expenditures from Treasury.

Consider a comparison of quantitative easing and helicopter money.

The actual observable case of quantitative easing (QE) is that of a central bank strategy that operates according to a recognizable division of responsibilities for the execution of the government budget and the ultimate financing of the budget. The QE process is time sensitive in terms of the order of execution of respective fiscal and monetary responsibilities. The government first executes fiscal policy using normal financing requirements in the form of bonds. The net fiscal effect of the initial money distribution, financed by bonds, is captured at the Treasury level. The central bank then executes monetary policy responsibility (at its own option) by converting (in effect) initial fiscal bond financing to money financing. The central bank buys the bonds following the fiscal implementation, and then holds the bonds on balance sheet. The result is tracked on the central bank balance sheet and income statement, including the effect on profit and the capital position. The future net fiscal effect of the ultimate financing method is thus captured at the central bank level. Profit is remitted to the Treasury, the same as in the conventional case. The future net fiscal effect of QE can then be gauged for its impact on central bank profit and remittance to Treasury, as has been evident in the case in the Federal Reserve’s outsized distributions to the US Treasury over the period since QE inception. (Of course, the original starting net fiscal effect of the government disbursement at the time of the original expenditure and associated bond issuance is the amount of the disbursement itself.)

The imagined case of helicopter money (HM) as generally proposed is different from QE, in part due to the different timing for the fiscal and monetary stages of this sequence. The helicopter story specifies that money expenditure and money financing are effectively coincident, rather than lagged as in QE. And because of this coincidence, its proponents seem to suggest that the central bank control both the fiscal function and the monetary function. This proposal amounts to a reverse takeover of policy and operating responsibility, guided by the deemed urgency of combining the fiscal effect with immediate monetary financing. The fiscal nature of the process as we have already described is defined by the fact that a disbursement is made with no other financial asset received in exchange. The central bank is imagined to produce monetary financing ex nihilo – with no other financial asset received in exchange. This runs parallel to Treasury bond financing in the normal course of deficit finance – also with no other financial asset received in exchange. By endowing this ex nihilo disbursement capacity to central bank operations, the HM proposal requires that the central bank now run a mismatched balance sheet, with no central bank asset corresponding to the helicopter monetary base expansion. In the case of QE, the net fiscal effect of the government disbursement is the amount of the money disbursement that has been rerouted (in effect) by bond issuance. In the case of HM, the net fiscal effect of the central bank disbursement is also the amount of the money disbursement, in this case money that has been newly created by the central bank.

The salient point in the comparison is that the chaotic central bank operational and financial architecture that is suggested implicitly for HM amounts to a shell game that submerges important long term fiscal contingencies. The generally accepted argument in favor of HM requires that the money financing be “permanent” (a la the Krugman liquidity trap thesis in the case of QE). It is not even clear what this means in terms of substantive balance sheet projections. Nevertheless, this mode of “permanence” suggests some pretty wobbly central bank balance sheet accounting and management as a means of facilitation. Any central bank governor agreeing to this condition would by implication be committing not to undertake reversing actions in the future that would drain the excess bank reserves that must inevitably result from HM. (Even in the original Friedman super-fantasy of an HM currency drop, it should be acknowledged that the public has a propensity to convert excess currency holdings to more manageable bank deposit balances).

With that kind of committed inflexibility, the central bank as an institution may as well be wound up and folded into the Treasury function, because it can no longer claim to have the same order of influence over monetary base growth. It is supposed to commit by implication to a “permanent” creation of excess bank reserves, whatever that means in terms of substantive balance sheet projections and scenarios. This is opposite to the type of control normally assumed in the case of QE, where the central bank independently constructs a plan for eventual QE “exit” with a corresponding withdrawal of excess bank reserves, depending on future monetary conditions. (The Fed is certainly doing this type of contingency planning now.) And even if in the case of HM there is an “off-balance sheet” commitment to recapitalize the central bank (at the option of either Treasury or the central bank), the obviousness of the shell game is still evident. The only purpose of such a ruse can be to avoid the creation and visibility of outstanding government debt, even though the net fiscal effect of debt while held by the central bank can be easily explained as neutral – in and of itself (the bond interest received by the central bank equals interest paid back to Treasury as part of profit). Thus, there is no fiscal substance to be found in the idea of making bonds “disappear” in an HM operation any more than there is in QE. The proposed absence of bonds is a ruse designed to fool people into thinking that there is no fiscal contingency associated with money financing. But this is not the case. The consolidated fiscal position includes the remittances that the central bank makes to Treasury, and those remittances are at risk in the future if the central bank increases the interest rate it pays on bank reserves – which it will do if and when monetary conditions allow interest rate lift off from the present “liquidity trap” situation. That sort of lift off is in fact the prevailing long term objective of monetary policy almost everywhere now, given the operational and strategic complications associated with a central bank being stuck at the zero lower bound. And most importantly, central banks do not want and should not want to commit to a state of permanently saturated banking system reserves. That would be a signal of secular institutional dysfunction (banks do not need those reserve balances for efficient functioning) and a cry for help in the form of more fundamental institutional redesign. (This again is important in the Fed’s current thinking.)

In contrast to the HM notion, the actual case of QE involves an effective transformation of financing for a government budget that has already been rolled out – the money has already been spent. QE converts the financing from bonds to money. HM as imagined has the same monetary effect, but with no time lag between the fiscal expenditure and the financing with money. However, the core spending component is fundamentally the same. It is fiscal spending – typically proposed in the form of a transfer. And so there is nothing to prevent the same kind of spending that is envisaged in the helicopter parable from occurring within normal debt operations or in the same sense as QE debt/money conversion, under a compressed time horizon that amounts to the coincidence of spending and money financing as proposed under HM. Treasury and the central bank both have the operational flexibility to achieve the desired result in terms of coordinated spending and ultimate financing – i.e. the flexibility to achieve the objective under existing institutional arrangements and responsibilities, thereby synchronizing the timing of the desired fiscal effect and its ultimate monetary financing. And in doing so, Treasury can then be consistent in assuming primary responsibility for the policy that directs the kinds of fiscal payments that are proposed under HM. The policy is fiscal, with monetary accommodation as planned in execution of the policy.

For example, under a policy of such operational coordination, the central bank can buy bonds from the market in an amount equal to the fiscal expenditure at or around the time of that expenditure. In a more extreme adaptation, the law might be changed to accommodate direct monetary financing at the point of issuance – but only for this designated type of fiscal program. That’s a bigger leap, but it beats the alternative of a central bank that independently blows a hole in its balance sheet with direct fiscal expenditures, mangling the institutional alignment of responsibilities across the board in the process. That said, it is not essential to the objective of money financing that the bonds acquired be the same bonds issued at the point of fiscal expenditure. The essence of the idea is to create monetary financing in coordination with the fiscal expenditure and at the time of the expenditure. It is the quantity of bonds acquired and money created at the same time rather than the matching of bonds acquired to bonds issued that is important to the idea.

Conversely, the HM idea as proposed leads to central bank balance sheet distortion due to the capital effect of ex nihilo fiscal disbursements. As a possible “fix” for this potential effect, Treasury might recapitalize the central bank balance sheet as ongoing disbursements are made. The balance sheet capital hole created by fiscal spending could be refilled by recapitalization with bonds that serve as the nominal asset backing for the bank reserves that have been created. This effectively transfers the balance sheet mismatch and the fiscal cost resulting from the central bank disbursement back to Treasury, as is the normal case for fiscal expenditures. But this is an awkward correction to a financial management arrangement that is unnecessary and dysfunctional at the outset.

Instead of that type of fix, the problem should be avoided at the beginning. The fiscal disbursement – in this case the “HM drop” – should be made by Treasury, as is normally the case with fiscal disbursements. And bonds should be issued by Treasury as usual. The truly effective “drop” characteristic of HM is in fact a function of the money that is disbursed to recipients – whether that money is disbursed by the central bank or by Treasury. The public receiving the money is interested in the money only, and has no interest whether or not bonds are issued. And when the bonds are issued as usual, they (or other bonds, as noted above) can be vacuumed up immediately by the central bank. After all, it is not necessary in order to achieve the substantive fiscal “drop” effect that the money paid to the drop recipients be the same money that the central bank creates. This is a matter of procedural arrangement, accelerating the time sequence of normal QE, as described above, while still achieving near-simultaneous coordination of the fiscal transfer and the end profile for money finance. This central bank action of compressed-time-QE purchases of HM-linked bonds is what increases the aggregate supply of bank reserves (and broad money in the usual case of non-currency disbursement). But it doesn’t change the fact that the recipients will have already received HM “drop money” and couldn’t care less themselves whether bonds have been issued in the process (another hint as to why this is at root a fiscal exercise). Moreover, the consolidated fiscal effect of the bonds per se is zero, so long as they are held by the central bank. This once more reinforces the essential fiscal nature of the decision to spend money that is at the root of the HM idea.

To recap, given the urgent timing desired under the HM disbursement idea, proper recognition of the primary fiscal effect requires either simultaneous recapitalization if the central bank writes the check, or simultaneous QE-type bond purchase if the Treasury writes the check. At the end of the day, there is no reason for the central bank to write the check for the fiscal disbursement, since the very same result can be achieved by fully coordinated expenditure with money financing, using compressed-time QE. That obviates the need to “fix” the fiscal effect of a central bank transaction that needn’t and shouldn’t have taken place in the first place.

As is the case with QE, there may well be a fiscal benefit resulting from the HM concept when compared to the scenario of market bond financing – if and so long as the interest rate paid on bank reserves is less than the interest rate paid on alternative market bonds. And as with either market bonds or QE bonds, the gross debt to GDP ratio is a calculation that includes all bonds issued by the government, including those held by the central bank. But an intelligent interpretation of the gross debt position should always consider the effective transformation of the interest rate cost in respect of any bonds held by the central bank. And just as important, the analysis of the fiscal position should recognize balance sheet risks and contingencies over the longer term, such as potential QE exit or some similar reversing action in the case of HM.

HM as visualized suggests the illusion of a “permanent” free lunch. But future interest payments on HM created bank reserves are no less risky than future interest payments on QE created bank reserves. And while there may be a difference between the interest rate paid on bank reserves and the interest rate paid on Treasury bills (or longer term bonds), the essential nature of the interest rate risk and the fiscal consequence that results from the monetary policy for both QE and HM is fundamentally the same. This interest expense is part of the net profit determination for the central bank and its consequent remittance to the Treasury, and therefore is part of the net fiscal effect of central bank operations. While the typical taxpayer will not fully appreciate the workings of the consolidated government balance sheet or the consolidated interest cost of the government budget, he or she can probably sense in at least a vague way institutional changes (e.g. negative central bank capital) that seem benign enough when interest rates are near the zero bound, but which mute an awareness of expense contingencies down the road in the form of potentially higher interest costs on bank reserves. These prospects should be assessed and explained as a matter of thorough financial analysis and risk management, rather than hidden in the murky accounting world of the typical HM proposal.

Numerous economists believe that the helicopter money idea constitutes “out of the box” thinking, and that the time has come to implement Friedman’s wacky analogy as a central bank undertaking. But if the proposal is understood for its substantive implications, it can only be interpreted rationally as fiscal policy with immediately co-ordinated monetary policy. The usual proposal sees the disappearance of bonds from the central bank balance as a catalyst for a central bank claim of fiscal responsibility for helicopter money. But what responsible central bank governor would agree, in the absence of bonds held as assets, not to have a documented bond recapitalization contingency plan that would at least allow for the possibility of draining HM created excess bank reserves at some point in the future? And why should he or she even agree to that, when the bonds that should already be in place contribute zero net interest expense for the consolidated fiscal cost, so long as they are held by the central bank? Do economists really believe that “expectations” become more efficiently informed if, for the sake of a superficial impression of “permanence”, the capacity to deal effectively with future monetary policy contingencies is left ambiguously adrift? This amounts to irresponsible financial management, with an unnecessary and inappropriate imposition of stark inflexibility on central bank authority, where the only “benefit” is the avoidance of an apparent need to communicate that the payment and receipt of interest on government bonds held by the central bank has zero net fiscal effect so long as the bonds are held in the central bank’s portfolio.

The debate about HM has featured much discussion and tinkering as to what constitutes monetary policy and what constitutes fiscal policy. This has tended toward unproductive manipulations of institutional responsibilities, with old vocabulary in search of new meaning. To take the earlier example again, characteristics as flimsy as the effect of central bank interest rate operations on the present value of government debt cannot be taken seriously as a line of logical justification for fundamental realignment of fiscal responsibility. The proponents of HM seem driven by a desire to avoid the creation of government bonds that in fact have no net fiscal effect on their own account while held in the central bank portfolio. It is as if the entire institutional framework is uprooted simply because somebody can’t be bothered to footnote the usually favorable debt servicing cost effect of central bank holdings of bonds when analyzing the debt to GDP ratio.

Yes, the central bank has the responsibility for managing the monetary base. And yes, that along with short term interest rate control is the essence of monetary policy. But that does not mean that the central bank has the exclusive authority to expand the monetary base using any operation imaginable under the sun. The central bank operates under what is in effect a delegated authority from its ultimate fiscal master, somewhat analogous to a risk taking authority that a commercial banking trading unit may receive from a high echelon asset-liability committee. This is an “authority” that is designed with fiscal consequences in mind, such that the central bank has the operational independence to execute monetary policy under that authority and under the laws that define its institutional responsibilities.

In summary, real time coordination of fiscal and monetary policy (as desired under HM) doesn’t warrant a conflation of fiscal and monetary policy responsibilities or incoherent fiscal accounting. HM proponents come at the situation with notions about central banks somehow taking control of fiscal policy and driving the implementation with an unnecessarily destructive effect on their own balance sheets. Immediate money financing for approved fiscal actions is the substantive objective, and the operational means to achieve this objective lies in the design of coordinated fiscal and monetary plans within the existing institutional framework – not in speciously dodging the presence of government bonds on the central bank balance sheet.

]]>“Free Trade” and Risk-adjusted returns – The impact on middle class familieshttp://monetaryrealism.com/free-trade-and-risk-adjusted-returns-the-impact-on-middle-class-families/
Fri, 01 Apr 2016 17:43:35 +0000http://monetaryrealism.com/?p=3477Read More]]>David Glasner has written an excellent post on how most people consider their work to be far more important than what they consume – so what our economy gains with free trade is different than what most people value in their lives. Free trade puts their jobs at risk, and they get to consume a bit more.

For most people, an increased risk of losing your job is not worth moderate gains in their consumption. The absolute returns from free trade might be higher to them, but how about the risk-adjusted return?

Here is David:

“What people do is a far more important determinant of their overall estimation of how well-off they are than what they consume. When you meet someone, you are likely, if you are at all interested in finding out about the person, to ask him or her about what he or she does, not about what he or she consumes. Most of the waking hours of an adult person are spent in work-related activities. If people are miserable in their jobs, their estimation of their well-being is likely to be low and if they are happy or fulfilled or challenged in their jobs, their estimation of their well-being is likely to be high.

And maybe I’m clueless, but I find it hard to believe that what makes people happy or unhappy with their lives depends in a really significant way on how much they consume. It seems to me that what matters to most people is the nature of their relationships with their family and friends and the people they work with, and whether they get satisfaction from their jobs or from a sense that they are accomplishing or are on their way to accomplish some important life goals. Compared to the satisfaction derived from their close personal relationships and from a sense of personal accomplishment, levels of consumption don’t seem to matter all that much.

Moreover, insofar as people depend on being employed in order to finance their routine consumption purchases, they know that being employed is a necessary condition for maintaining their current standard of living. For many if not most people, the unplanned loss of their current job would be a personal disaster, which means that being employed is the dominant – the overwhelming – determinant of their well-being. Ordinary people seem to understand how closely their well-being is tied to the stability of their employment, which is why people are so viscerally opposed to policies that, they fear, could increase the likelihood of losing their jobs.

To think that an increased chance of losing one’s job in exchange for a slight gain in purchasing power owing to the availability of low-cost imports is an acceptable trade-off for most workers does not seem at all realistic.

“

This is just fantastic set of points:

Workers care more about their job than what they consume

Losing a job has a far larger impact on well-being than minor increases in consumption welfare

Steve Randy Waldman has made similar points before about how difficult it is to sum up gains from trade. Still, I think there is a related point which isn’t being made strongly enough. The risk of losing your job from free trade as it exists today for US workers located in the midwest almost certainly has swamped any possible benefits from slightly lower prices they might pay.

Imagine you are a working in a factory located in a small town in the midwest – like London, Kentucky. Imagine a plant closing and going overseas – so you and roughly 500 other people lose their job in this town. 500 people at a single is an underestimate – I personally know a facility in London that employs far more than 500 people.

The population of London, Ky is 7,993 in 2010- but I bet it has grown since then, so lets give it 8,500 people.

This plant closing and going overseas potentially ruins your life, and potentially ruins the life of nearly everyone you work with, and makes everyone in your town poorer.

You are probably not getting another job in London. You will have to travel to get work if you can find it. Even if you do find work in London, 500 other people are also looking for work. Getting a job means you are getting a job instead of someone you probably know personally. So even if you get great news for you, terrible news for your buddy and his family. Glad to survive, not so glad to see your friends not do as well.

Your situation is actually worse if you worked hard and got promoted a few times! Getting a management job was hard, now you will find it financially difficult to go back to working for less money – and other companies less likely to hire you for line worker jobs, as they think you will jump ship as soon as you get a better offer.

Anyone with 50% of a brain can see this doesn’t even have to happen to the place where you work personally. A plant with 500 people closing a few towns over makes you worry about your own plant closing. It brings new people into town to compete for jobs, people who look really hungry for your job. You’ll probably know at least a few people that lose their jobs – and see how it impacts them and their families.

The risk associated with losing your job is vastly higher when we have “free trade” like we have today. Even if the entire country ends up a with a bit more stuff, the added riskiness to living is significant for many, many people.

In finance, it’s extremely common for analysts to compare risk-adjusted returns. Risk-adjusted returns are a far better way to think about how much you are getting for an investment than flat-out gross returns.

So, for people facing competition from “free trade” agreements, what is the risk-adjusted return of “free trade” to them personally? Undoubtedly, middle-class families are getting much, much lower risk-adjusted returns on their family income than they would under some level of protectionism.

Here is something else to consider – free trade impacts people who are probably more risk adverse than most people. How would you describe someone who likes living in a small town, and working in a not-very-stressful job? Risk adverse fits. And yet these are the people who are most at risk to lose their jobs to outsourcing from free trade.

We should probably at least be considering the risk-adjusted returns to family income for “free” trade. It doesn’t seem to be something that has been examined at length – despite the fact lower risk-adjusted income is dominating one of the dominant themes in this election.